Goldman Gets Akamai Wrong

Beyond valuation, we are also concerned about intensifying competition as private entrants proliferate and selected large network operators begin to eye the space ... While portions of Akamai's customer base are likely relatively immune from competitive pressures, we believe that the majority of Akamai's 2,700 customers will be able to put increasing pressure on the company as contracts come up for renewal this year.

My response? Go sell crazy somewhere else.

Whining on Wall StreetOf course, I can't entirely blame Goldman for its conclusion. A huge part of the problem is Wall Street and the caffeine-and-sugar crowd that moves in and out of stocks like Jeff Gordon at Daytona.

To these traders -- no one with this itchy a trigger finger can reasonably be called an investor -- Akamai was worth only a few points. Bank 'em and move on, the thinking goes.

But Goldman isn't entirely blameless. New entrants? Large players? Talk about a sweeping analysis. Why not just say anyone with a data center is a threat? It's happened before. Google (Nasdaq: GOOG) was dubbed a competitor once for that very reason.

Here, AT&T (NYSE: T) is allegedly the gorilla that could eat Akamai's bananas. Ma Bell, which reportedly outsources a fair amount of content delivery to Akamai, is thinking of building its own content delivery network (CDN).

The horror!

Or is it? The risk in Goldman's analysis is that it ignores the details. Here's how Dan Rayburn, a veteran watcher of the content delivery industry, put it recently:

Based on my briefing with AT&T and the details I gave out about the scale of their build-out, if they end this year with the 400Gbps they are aiming for, across all of their CDN service, video, software downloads, app delivery etc. ... that would give them a fraction of what Akamai has. Not to mention no transcoding service, content management, DRM and all the other functionality that Akamai's Stream OS product has.

Translation: Even with the build-out, AT&T is still a lightweight compared to Akamai.

And let's not whitewash history. Big data center operators were going to displace Akamai years ago. They didn't because content delivery isn't merely a bandwidth game. You can't just buy servers and storage and become a content delivery network. At its essence Akamai is Google -- a math company that created an algorithm for Web traffic delivery rather than search.

Courts have upheld Akamai's intellectual property rights in this area. That's no small thing; it means that every competitor, AT&T included, is going to have to pass the test that former peer Speedera and current rival Limelight (Nasdaq: LLNW) failed.

Once more with the numbersGoldman may have a point in that pricing will take a toll on some Akamai customers. Churn rose to 4% in the most recent quarter, for example.

But the essence of the business remains. More than 100 customers spend at least $1 million on Akamai services annually. And its average revenue per customer was up 21% to $23,200 in Q1. Apple (Nasdaq: AAPL) and Microsoft are among the list.

Finally, I think Goldman's thesis depends on the market for content delivery slowing or at least normalizing. Only then would a bare-knuckles fight for market share make sense.

Evidence points to the contrary. Online video is surging, up 64% in March, according to comScore. And web content is important enough that CBS just agreed to acquireCNET (Nasdaq: CNET) for $11.50 a share.

Even so, Goldman may be right over the very short term. Churn may rise as industry newcomers play the cheap card. Over the long term though, in tech, low-cost leaders rarely become market leaders. Those that provide value -- Google, VMware (NYSE: VMW) , and, yes, Akamai -- do.

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Here is the foolish thing: Goldman Sachs owns 30,343,532 shares of Limelight, the company Akamai is suing out of existence. Since July of last year, due mostly to the suit, GS has lost $599 million dollars of value in the LLNW shares. On the day of the GS downgrade, AKAM lost about $600m in market cap. Now that Akamai and Goldman Sachs have hurt each other evenly, it will be interesting to see what the next move is.

I agree with Tim's position on Akamai. Akamai has a worldwide network of close to a 100,000 servers running a proprietary set of software applications that deliver cutting edge user experience to web surfers at a cost that is below the build cost for any business IT Department regardless of the size of the business. They have unlimited growth potential at this point and an incredible lead versus the competition. It will take time because they don't control their growth rate, it is controlled by external parties (users of their technology).